OREANDA-NEWS. Fitch Ratings says that the fundamentals underpinning Southern European banks' ratings are broadly continuing to stabilise, albeit with notable divergence in the pace of recovery across countries.

In Southern Europe, 44 banks have Stable Outlooks on their Long-term IDRs, while 11 have Positive Outlooks and only one is on Negative Outlook. Banks with Positive Outlooks are largely concentrated in Spain, reflecting some upside potential from Spain's improved operating environment.

With the exception of Greece, Fitch expects modest real GDP growth for countries in the region in 2016. This should support new lending, although net loan growth is likely to remain low, also in view of sizable back-book amortisation.

Fitch expects asset quality to remain weaker than for northern European banks for the foreseeable future. A large stock of impaired loans means that it will take time for banks in the region to normalise the proportion of capital that is tied up to unreserved problem assets.

An improved macro picture should support earnings, but it will be challenging for most banks to materially grow earnings in an environment of continued low interest rates and with limited scope to further reduce funding costs. However, scope for provisions to normalise further provides some earnings upside.

Banks' funding and liquidity profiles should continue to benefit from reduced reliance on central bank funding. Fitch expects take-up by Southern European banks of targeted longer-term refinancing operations to be low in 2016, partly because banks generally hold ample liquidity buffers. This is exacerbated by more limited opportunities to generate carry-trade income.

Fitch sees some scope for consolidation in the region, for example involving some Spanish mid-sized banks and also in the Italian cooperative banks space following banks' transformations into limited companies.

Ratings for most banks in the region are sensitive to impaired loan trends and strengthening profitability of core banking operations and therefore ultimately to ongoing economic recovery.