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S&P warns it may downgrade EU, large euro zone banks

EU flags fly at the European Commission headquarters in Brussels.

Yves Logghe/AP

Standard & Poor's warned on Wednesday that it could cut the credit ratings of the European Union and large euro zone banks if a mass downgrade of euro-zone countries materializes.

S&P said on Monday it may downgrade nearly all 17 euro-zone countries if EU leaders fail to agree on a solution for the region's debt crisis during Friday's summit.

The potential downgrade of the European Union has no impact on the ratings of other EU countries that are not part of the euro zone, a spokesman for S&P said. However, the move would likely increase the EU's borrowing costs, making it more costly for it to fund financial aid programs for member states.

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S&P placed the European Union's triple-A credit rating on credit watch negative, noting that euro zone members, or countries that are part of the region's monetary union, contributed about 62 per cent of the EU's total budgeted revenues in 2011.

"Our review will focus on the financial ability of euro zone member states to support the EU's debt service should the institution face a period of financial distress," S&P analysts Frank Gil and Moritz Kraemer said in a report.

If euro-zone countries are downgraded, the European Union could have its rating cut by one notch, they added.

The European Union and the European Atomic Energy Community borrow on capital markets under a joint program to issue up to €80-billion ($107-billion U.S.) in medium-term notes in order to finance member states through various channels.

In another follow-up to its warning on Monday, S&P said some of the euro zone's largest banks, such as BNP Paribas and Deutsche Bank, could have their ratings cut following a potential downgrade of euro zone countries. S&P's downgrade warnings for key euro-zone countries has increased pressure on policy makers to find a solution to the debt crisis quickly.

The move drew strong criticism from euro zone governments, which accuse the agencies of unduly inserting themselves into the political process. But many market participants welcomed the move, saying that by signalling more clearly their possible actions, ratings agencies are reducing market uncertainty.

"[The agencies]became activist and they became proactive," said Enrique Alvarez, head of strategy at IDEAglobal in New York. "In past crises, I don't think that ratings agencies were willing to telegraph as much information as they are now to the markets.

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"This is very favourable for market transparency and it's very favourable overall to investors because there will be no shock next week if European policy makers don't come up with something valuable this weekend," added Mr. Alvarez.

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