Positive bias in bank ratings continued to be eroded in the fourth quarter of 2007 as the number of negative rating actions accelerated, Fitch Ratings says.

According to the latest report from Fitch, a continuation of the current illiquid and volatile market conditions could lead to further pockets of negative rating action in 2008. It notes that globally 78.3% of bank ratings still have a stable outlook, but Fitch expects rating deterioration to continue in 2008, and adds that pockets of negative rating actions are likely if the current volatile market conditions persist.

“Higher funding costs are likely to exacerbate risk aversion and reduce lending demand, while a slowdown in economic growth would undoubtedly mean higher risk costs for banks,” says Alison Le Bras, managing director in Fitch’s Financial Institutions Group. “Earnings and, in some cases, capital are thus likely to come under pressure in 2008.”

While the liquidity shock that first hit financial markets in August 2007 resulted in only a handful of negative rating actions in the third quarter, it marked a turning point in bank rating trends, Fitch says. The negative movement intensified in Q4 with the number of negative rating actions accelerating to 69 from 13.

The turnaround was most marked in developed markets, where there were 19 outright downgrades during the quarter, the majority in the Americas and Europe, where banks have been most affected by the ongoing global financial turmoil, the rating agency says. Outlooks on a number of ratings have also been revised downward to reflect continuing vulnerability to aftershocks from the credit crisis. As a result, the ratio of positive to negative outlooks fell to 2:1 in Q4 from 5:1 in the first quarter of 2007.

Of particular note are the negative rating actions taken on some of the large U.S. banks, such as Citigroup and Bank of America as well as investment banks, Bear Stearns, Morgan Stanley and Merrill Lynch. In Europe, the main casualty to date has been the Swiss banking giant, UBS AG.