Luxembourg’s banking system is one of the least risky in the world, a global credit bureau has found. The Grand Duchy ranked in the top quintile in both “economic risk” and “industry risk” out of 83 jurisdictions in a new study by ratings agency Standard & Poor’s.

Prudent government policies and a conservative banking culture were plusses, while its higher-end client base and regulatory complexity were minuses, according to the “Banking Industry Country Risk Assessment: Luxembourg” report, published on Wednesday.

Economic risk

S&P gave Luxembourg an economic risk score of “2”, with “1” representing the lowest and “10” representing the highest level of risk. Other countries with the same economic risk score included Austria, Belgium, Canada, Finland and Japan. Only Germany and Switzerland had the best score of “1”.

“Economic risks for Luxembourg’s banks remain relatively low in a global comparison,” the report said. However, the country’s economic “concentration on [the] financial sector and position as a financial center make it vulnerable to ongoing regulatory pressure in the next few years,” S&P said.

The agency’s analysts viewed the Grand Duchy government’s pragmatism as an advantage. “We believe that Luxembourg will benefit from sufficient fiscal flexibility to adapt to Europe-wide measures”, including the proposed financial transactions tax and a reform of multinationals’ taxation, “should they be implemented”.

The credit bureau predicted the Grand Duchy’s public debt was “likely to spike in 2015”, but did not expect radical changes under the new government. “We think that the new, three-party coalition between the liberal Democratic Party (DP), the center-left LSAP, and the Greens, in place since Dec. 4, 2013, will continue on a similar policy course, putting public finances and the economy as priorities.”

S&P said the Grand Duchy’s banks had “conservative” lending and debt management practices. “In our view, Luxembourg banks have only prime mortgages and they use securitization only rarely, if at all.”

Industry risk

The Grand Duchy’s banking industry received a slightly higher industry risk rating: “3”. That placed it on par with countries such as France, Germany, the Netherlands, Sweden and the UK. Banking systems in Australia, Canada, Hong Kong, Saudi Arabia, Singapore and Switzerland received better industry risk scores.

“In our view, industry risk mainly stems from banks’ focus on private banking and wealth management. We believe the high confidence sensitivity of this business model exposes Luxembourg’s banking industry to reputation and regulatory risks,” S&P said.

Nevertheless, the ratings agency gave the Grand Duchy’s supervisorial regime good marks. “Luxembourg’s regulatory framework is in line with--or in some cases, stricter than--that of the EU”, for example, when it comes to Basel liquidity requirements and European stress tests.

CSSF challenges

“However, we consider that the supervisory work of the Commission de Surveillance du Secteur Financier (CSSF) is challenging because most banks are part of larger international groups, that are supervised on a consolidated basis by the regulator of the parent's headquarters (home regulator), whereas the CSSF is only a national regulator (host regulator). This issue is partly addressed by close cooperation with supervisory bodies in other countries.”

S&P estimated that financial services contributed “about 25% of GDP and employ 20% of the population”, which has added “to the complexity of the supervisory regime. In our view, supervisors and financial authorities aim to keep a balance between preserving the financial stability and the reputation of a country, while maintaining the attractiveness of a financial center,” the report said.

The Grand Duchy’s banking sector received the exact same ratings in S&P’s January 2013 review.