OREANDA-NEWS. Last week's Irish sovereign upgrade does not automatically mean that the country's banks will follow suit, says Fitch Ratings. Rating drivers for the sovereign and the banks differ, and although Bank of Ireland (BOI) and Allied Irish Banks (AIB) are likely to benefit from the improving operating environment that contributed to the upgrade, the banks' weak asset quality is an obstacle to upgrades in the short term.

The ratings gap between the sovereign (A/Stable) and the banks is considerable: four notches for BOI (BBB-/Positive) and five for AIB (BB+/Positive). Asset quality is the key vulnerability for these banks and working through the EUR30bn backlog of impaired loans will take time. In the meantime, this vulnerability constrains their fundamental creditworthiness.

Nevertheless, the banks have made good progress in reducing their stock of impaired loans and we think this trend will continue. Data released by the European Banking Authority in November 2015 showed that Irish banks were among the EU's most active in reducing stocks of non-performing loans. Our view is that the medium-term growth potential of the Irish economy is 2%-2.5%, which should provide a more favourable backdrop for banks' continued working-out and offloading of impaired assets.

The key sovereign rating driver is improving public debt dynamics, which were most important to the upgrade. Government debt as a percentage of GDP continues to fall, to below 100% at end-2015 from a 120% high in 2012. Our base scenario, which excludes inflows arising from privatisation of BOI and AIB, shows public debt falling steadily to 70% by 2024.

Our latest sovereign Rating Action Commentary and Rating Action Report, available by clicking on the links below, provide information on the quantitative and qualitative factors behind the sovereign rating.