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Standard & Poor's (S&P) Ratings Services downgraded its long-term counterparty credit ratings on Barclays PLC (BCS - Analyst Report), Deutsche Bank AG (DB - Analyst Report) and Credit Suisse Group AG (CS - Snapshot Report). The rating downgrade was primarily due to the new regulations and economic uncertainty weighing on their investment banking operations.

The rating agency lowered the long-term counterparty credit ratings for Barclays and Deutsche Bank to “A” from “A+,” while Credit Suisse was reduced to “A-“ from “A”. However, S&P affirmed its long-term and short-term ratings on UBS AG (UBS - Analyst Report). The outlook for all these major European banks is stable.

Reasons for the Downgrade

The rating agency believes that these banks are reviving after the financial crisis in 2008. The financial said crisis had prompted regulatory bodies all over the world to identify risky businesses and frame new regulations against them. Additionally, the rating agency believes that these 4 banks are exposed to proposed litigations that will likely hamper revenues from trading and investment banking operations.

Further, S&P believes that capital market operations are under pressure due to mounting litigation costs, which resulted from the financial crisis. In addition, tighter regulatory environment, sluggish economic growth worldwide and a stagnant European economy has worsened the scenario.

Regulations: Boon or Bane?

New regulations like the Volcker’s rule, which constrained banks from indulging in risky trades, the European Union’s rules pertaining to payment bonuses and the proposed U.S. rules for foreign banks could be headwinds to profitability.

Barclays – Britain’s third largest bank by market value – is heavily dependent on revenues from its investment banking segment, which contributes about 46% of total revenue. Deutsche Bank – the biggest German lender, is facing mounting pressure in its investment-banking operations. Both these banks will need to fulfill stringent capital and liquidity requirements for overseas banks operating in the U.S.

Swiss banking major, Credit Suisse garners about 50% of its total revenue from investment banking operations. Even though the Zurich-based bank improved its capital position and took steps to carry out an extensive restructuring to cut costs, it could face volatile earnings and revenues in the near term.

However, we believe the rating agency reiterated its rating on UBS AG as it is actively reducing its exposure to investment banking and risky ventures. In Oct 2012, UBS declared its intention to go ahead with 10,000 retrenchments and move away from capital-intensive trading businesses worldwide.

Our Viewpoint

Under the Basel III rules, banks operating in the U.S. have been compelled by regulators to maintain a larger capital buffer to counter economic downturns in the future. While this led investment banks to reduce risky trading, it restricted their revenue growth. Further, with the eurozone debt crisis, banks have been incurring trading losses and outrage worth billions of dollars. More stringent rules by regulatory authorities have exacerbated matters.

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