World Bulletin / News Desk

Italy's banking and business community responded angrily on Tuesday to Moody's mass downgrade of Italian banks, calling the move irresponsible and an assault on the austerity-hit country as it struggles with an economic crisis.

Italian banks, already battling with shrinking demand and soaring bad loans, suffered a further blow as the U.S. agency slashed the credit ratings on 26 local lenders, adding to their difficulties in raising funds.

The downgrade, which Moody's pinned on a weakening operating environment made worse by Prime Minister Mario Monti's tough austerity cure, came amid growing calls within the euro zone for a shift towards growth after months of strict fiscal discipline.

Pro-growth French President Francois Hollande is likely to press for a counterweight to austerity when he meets German Chancellor Angela Merkel against a backdrop of Greek political instability and a deepening of Spain's banking troubles.

"Moody's decision is an assault against Italy, its companies, its families," said Italian banking lobby ABI. "Once more rating agencies turn out to be a destabilising factor for financial markets with their partial and contradictory statements."

Big business lobby chief Emma Marcegalia said she was concerned by such an "attack against Italy."

Moody's downgrade came on the back of its February cut of Italy's sovereign rating to A3 from A2 and makes the ratings of Italian banks among the weakest in western Europe.

While large groups such as Intesa Sanpaolo and UniCredit have enough international reach and capital to absorb the hit, this is more problematic for smaller lenders such as Banca Monte dei Paschi di Siena, which now stands just above "junk" or non-investment grade status.

Repeated rounds of credit rating downgrades have added to funding difficulties for banks in the weakest euro-zone members, increasing their reliance on European Central Bank (ECB) funds.

Low ratings are also scaring off large investors such as money-market managers and pension funds, which often rely on rating agencies' marks to guide their investment strategy.

Role questioned

Ratings agencies were heavily criticised after the 2008 financial crisis and have been under fire again in Europe.

Italy's business community and some regulators have been at the forefront of criticism of the three top agencies: Standard & Poor's and Fitch as well as Moody's. Italian prosecutors have also opened a probe into the three for possible market rigging.

"It is very urgent to review the role of rating agencies and the way they operate. They often come too late. In such volatile market conditions their action is useless if not outrightly damaging," Banca Ifis head Giovanni Bossi told Reuters.

Italy market regulator chairman Giuseppe Vegas warned on Monday against possible conflicts of interests between rating agencies and investors, and suggested the use of ratings should be curbed to avoid exacerbating the crisis.

With a focus on retail services and despite having steered away from subprime bonds, Italian banks are considered risky as they suffer from the double-edged sword of growing Italian bond holdings and contracting internal demand.

Italian banks have been big buyers of domestic bonds and their role is vital for the refinancing of Italy's 1.9 trillion euro ($2.4 trillion) public debt. They upped their holdings of Italian bonds by 9 percent to 290.54 billion euros in March.

But their exposure to sovereign risk makes them vulnerable while concerns persist about euro zone integrity.

Tax hikes and tough pension reforms introduced by Monti's technocrat government have deepened Italy's economic woes, at least in the short term. Italy's economy contracted by a larger-than-expected 0.8 percent quarter-on-quarter in the first three months of 2012.

"The rating agencies are a bit fickle, sometimes they attack countries and companies because there is not enough austerity," said BNL Chairman Luigi Abete. "We should take these assessments with a huge pinch of salt, our banking system is solid."

Even though Italian banks met immediate funding needs by scooping 255 billion euros of generous three-year ECB loans offered in two auctions, doubts remain over their longer-term ability to fund themselves if sovereign worries persist.

UBI Banca, Italy's fifth-largest bank, said in its earnings release on Tuesday it could not fund itself through the market in the first quarter of 2012. It took 12 billion euros of cheap longer-term ECB funds, enough to meet its needs through 2014.

Intesa, Italy's biggest retail bank, said as it published earnings it had already covered 50 percent of its 2012 maturities, partly by tapping wholesale markets.