Banca Popolare di Milano (BPM) and Banca delle Marche were put on review for downgrade by Moody’s on Friday because of deteriorating asset quality and low capital generation against a challenging economic climate in Italy.

BPM may lose its Baa3 rating as a result of a 31% annual increase in problem loans, which were reported as amounting to 10.7% of loans in September. In combination with the bank’s high exposure to the real estate and corporate sectors, this may undermine BPM financial strength, said Moody’s.

The focus of the review will be the effectiveness of BPM management in improving the bank’s financial flexibility and in implementing a planned reduction in the real estate concentration from 24% to 21% of loans by 2015.

Banca delle Marche’s rating of Ba1 was also put on review for downgrade over concerns on problem loans, which reached 14.3% of loans in June. However, Moody’s said that a capital increase of Eu180m in the first half of this year provides Banca delle Marche with “a sufficient buffer under Moody’s central scenario, but renders the bank vulnerable to losses under the rating agency’s adverse scenario”.

Moody’s expressed concerns over the two banks’ reliance on European Central Bank (ECB) funding and forecast that access to wholesale funding will be “restricted and costly for an extended period”. Moody’s review of Banca delle Marche will be focused on its ability to diversify funding, while the impact on profitability of ECB funding will be assessed in its review of BPM.

Moody’s noted that a challenging economic climate in Italy is putting the two issuers under stress. The rating agency expects the negative outlook for the Italian economy to continue, as unemployment reached 10.8% in September and GDP is expected to be flat or decrease by 1% in 2013.