Fitch Ratings is launching a new product that aims to assess the vulnerability of banking systems to distress. Currently, most banking systems look solid, it says.

“Banking crises have affected almost 100 countries in the past 25 years and can have a major impact on sovereign and bank ratings” said Richard Fox, senior director in Fitch’s Sovereign group, in a release. “This new methodology will help identify potential problem situations which could lay countries open to future systemic distress by pooling the expertise of Fitch’s Sovereign and Financial Institutions Groups.”

It notes that higher quality, stronger banking systems are better able to absorb shocks than lower quality, weaker systems, “where even a modest increase in stress may be enough to cause a full-blown systemic crisis that exhaust much or all of a system’s capital and requires financial support from either the government and/or shareholders”.

Fitch finds that 70% of banking systems show little sign of vulnerability to potential stress arising from excessive credit and asset price growth or real exchange rate strength. But in about a quarter of countries Fitch’s early warning model suggests potential for problems to emerge in future unless there is moderation in the pace of credit growth and asset price inflation or real exchange rate appreciation.

In all these cases, private sector credit has risen significantly above trend and either equity prices (Estonia, Iran, Kuwait) or property prices (UK) or the real exchange rate (Australia, Finland, Ireland and Russia) or a combination of these indicators (Iceland) have also risen near to or above critical levels, derived from a study of past episodes of systemic stress.

In just two countries, Hungary and South Africa, Fitch’s model suggests high vulnerability to potential stress. “Both countries have witnessed major real exchange rate appreciation alongside strong private sector credit growth. In South Africa in addition, property prices have risen to unprecedented levels,” it explains. “However, in both countries structural changes may account for these trends and mitigate the potential risks. Moreover, South Africa has a high quality banking system. Hungary’s banking system is weaker like many emerging markets, and is less well placed to absorb credit and/or exchange rate shocks.”

Only five banking systems – Australia, Luxembourg, the Netherlands, the UK and US – are classified as very high quality. Most other developed countries have a high quality rating (including Canada), apart from Austria, Germany and Iceland whose systems are only rated “adequate”, and Japan whose system is assessed as low quality.

Most emerging market banking systems appear in the weaker categories from adequate to very low. Just five are classified as high quality, those of Chile, Estonia, Kuwait, Saudi Arabia and South Africa. At the other extreme 11 systems, all in emerging markets, are very low quality. Half of these are in Latin America and have recently suffered banking crises. The others are Azerbaijan, China, Egypt, Iran, Tunisia and Vietnam.