The FINANCIAL — Fitch Ratings — Deflation in the eurozone would put further pressure on banks, dampening earnings, increasing non-performing loans and weakening collateral values, says Fitch Ratings. “Japan-style” deflation scenario analysis for eurozone banks shows banks in peripheral countries with already weakened banking systems and low inflation would be affected first, according to Fitch Ratings.
Falling prices, wages and incomes reduce demand for credit and make existing debt harder to service, while falling asset prices weaken defaulted loan recoveries. But the knock-on effects on economic growth means there is likely to be an official sector response, which could ease banks’ pain.
The risk of deflation is increasing, but it is not our base case for the eurozone as a whole. We expect strengthening GDP growth and a narrowing of the output gap to help avert it.
Deflation would negatively affect several inputs to our Viability Ratings assessment, including the operating environment, asset quality, capital and earnings. The nature and extent of the impact would reflect the severity of deflation, its duration, and its variation across jurisdictions. The effect on individual banks would also depend on the creditworthiness of each bank, and any additional official sector policy responses, according to Fitch Ratings.
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