The latest research from Standard & Poor’s Ratings Services gives the global financial sector a generally good bill of health for 2004, but notes that there may be some soft spots.

S&P says that in the medium-term the need for a government to intervene to support its national banking system is generally low, although China’s banking sector stands out as the largest system vulnerable to stress.

“The leading indicator of potential stress in many developed countries is the continued rise in household debt and house prices, which have outpaced underlying economic growth for several years,” says Scott Bugie, Standard & Poor’s credit analyst. Under the negative scenario of rising real interest rates and unemployment and a sharp drop in house prices, certain banking sectors (in the U.S., U.K., Spain, Australia, and Ireland) could suffer from a hard landing, he warns.

Nevertheless, Standard & Poor’s predicts that a more moderate slowdown is more likely for these economies. It says the household sector in some previously overheated markets, such as the Netherlands, is already experiencing a slowdown, but with minimal effect on bank performance. And, short-term rates started to rise in 2003 in the U.K. and Australia, and this month in the U.S., signaling the start of a probable long-term phase of tightening that will likely slow demand for household credit.

Standard & Poor’s says the outlook on bank ratings and the overall banking industry in the countries cited as vulnerable is broadly stable. The ratings take into account a moderate fall-off in business flows and household credit in a slowdown. In the short term, the banking industry is more vulnerable to a decline in business volumes, as opposed to an increase in credit losses, triggered by a cooling of the household debt boom, it notes.

Most banks in these countries have some scope for cyclical deterioration in earnings and asset quality at their current rating levels, the rating agency says. Although low interest rates supported an expansion of corporate debt, the trend is softening and is not as universal as the retail credit boom.

“Broadly speaking, the corporate sector appears less vulnerable to a credit bust today than in the 1990s,” it says. “Corporate bankruptcies have been declining in North America and Europe since early 2003, and some overleveraged sectors, such as telecommunications, have shed part of the debt taken on during the economic expansion of the late 1990s.”

As for emerging market banking sectors, Standard & Poor’s notes a moderate trend of improvement in creditworthiness, primarily because of the restructuring and reform that has taken place since the crisis-filled period of 1997-2001, which affected most regions worldwide.

“An area to watch in emerging market banks is the rapid expansion of credit to individuals, a virtually universal phenomenon,” said Bugie. “The development of retail banking overall is positive for most sectors, but the sheer pace of expansion and untested nature of the retail loan market in many countries leaves open the possibility of stress further down the line.”