Ratings agency Standard & Poor's has downgraded its risk assessment level for Spain's banking sector, warning of 'high credit losses' during the country's recession.
"We believe that Spanish financial institutions are likely to operate in a difficult economic environment over a prolonged period," it said in a statement.
"Spain's financial system is likely ... to suffer high credit losses during the recession, owing to the corporate sector's high indebtedness, rapid credit expansion, and financial institutions' meaningful exposure to the real estate sector.
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"Problem loans will likely peak in 2010, according to our estimates, with higher-than-historical average credit provisions continuing through 2011," the agency said.
As a result the agency has downgraded its Banking Industry Country Risk Assessment (BICRA) rating for Spain "to Group 3 from Group 2," it said.
The scale incorporates the view of the strngths and weaknesses of a country's banking system compared to those of other countries and it ranges from Group 1, the strongest, to Group 10, the weakest.
The move leaves Spain's banking sector on the same level as that of United States and Britain and below those of Germany, France and Italy.
Spanish banks got off relatively lightly from the subprime mortgage crisis in 2008 as the country's strict regulations meant they did not invest heavily in the high-risk loans that hurt financial institutions elsewhere.
But there is growing concern over the flood of bad loans arising from the collapse at the end of 2008 of the country's property bubble, especially by Spain's small, regional and loan institutions called "cajas".
The Bank of Spain's head of regulation, Jose Maria Roldan, on Monday urged Spanish banks to "make supplementary efforts" to strengthen their balance sheets because "tensions in construction and property development will continue" in 2010.
The total exposure of Spain's financial system to the sector was worth 445 billion euros (610 billion dollars) as of the end of last year, he said.
"It is, without doubt, a high amount but the absolute figure in and of itself is not particularly significant," he said at a Spanish Mortgage Association conference.
Standard & Poor's credit analyst Elena Iparraguirre said the ratings agency had downgraded its risk assessment for the Spanish banking sector because of "the risks we see arising from the country's deteriorated economy".
But she said the Spanish financial sector "faces the difficult economic environment from a sound position ... thanks to its robust regulatory and supervisory framework, resilient operating profitability ... and the industry's strong retail banking segment."
The Spanish economy, the fourth largest in the eurozone, has been mired in recession since the global financial crisis hastened the collapse of its once-buoyant property sector at the end of 2008.
The recession sent the unemployment rate soaring to nearly 19 percent in the fourth quarter, the second highest level in the European Union after Latvia.
The agency last December lowered its credit rating outlook on Spain to "negative" from "stable," warning that the country faced a "prolonged" period of sluggish economic growth.
Last month, it warned that Spain could fail to meet its target of cutting the public deficit to within the EU limit by 2013 due to its "weak economic growth prospects."
Spain's problems have also triggered concerns that it could follow in the shaky footsteps of Greece, whose budget crisis prompted the EU to place it under unprecedented scrutiny.
