MILAN (Reuters) - Rating agency Standard & Poor's downgraded 34 Italian banks on Friday, including heavyweights UniCredit (CRDI.MI) and Intesa Sanpaolo (ISP.MI), citing a reduced ability to roll over their wholesale debt and expected weak profitability.
The move follows S&P's downgrade of Italy's sovereign rating last month to BBB+, part of a mass downgrade of nine euro zone countries.
In a statement, S&P said its so-called Banking Industry Country Risk Assessment had worsened to group 4 from group 3 -- out of 10 groups -- reflecting its more negative view on Italy's banking system.
"Italy's vulnerability to external financing risks has increased, given its high external public debt, resulting in Italian banks' significantly diminished ability to roll over their wholesale debt," it said.
"We anticipate persistently weak profitability for Italian banks in the next few years, and a risk-adjusted return on core banking products that may not be sufficient for banks to meet their cost of capital.
We believe this may be negative for the Italian banking industry's stability."
Italian banks have borne the brunt of a sell-off in Italian assets since the euro zone's third-largest economy was dragged into the single currency bloc's debt crisis last summer.
Because of their vast holdings of domestic government bonds, Italy's top five banks have been asked to find some 15 billion euros by June to meet tougher capital requirements set by the European Banking Authority.
Lenders have also been effectively shut out of wholesale debt markets and have increased their reliance on cheap funds from the European Central Bank.
Italian banks tapped a whopping 116 billion euros of nearly 500 billion euros of three-year funds offered by the ECB last December, easing funding strains.
A similar operation will be held at the end of February and analysts expect Italian banks to further increase their borrowing from the ECB.
S&P said weak profitability and increased cost of capital could lead Italian banks to write down a large part of the goodwill they booked during a wave of industry consolidation over the past decade.
Such writedowns forced UniCredit, Italy's biggest bank by assets, to announce a 10.6 billion euro loss in the third quarter of 2011.
Among the banks downgraded, Banca Monte dei Paschi di Siena (BMPS.MI) and Banco Popolare BAPO.MI had their rating cut below that of Italy's sovereign debt.
Reporting By Silvia Aloisi, editing by Dave Zimmerman