By Agencies

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At least 26 Italian banks have had their long-term debt and deposit ratings downgraded by credit ratings agency Moody's, citing the country's recession and rising bad debt levels.

Moody's said all the banks affected had a negative outlook and that some had been downgraded at least one notch while others by as many as four notches.

"The ratings for Italian banks are now amongst the lowest within advanced European countries, reflecting these banks' susceptibility to the adverse operating environments in Italy and Europe," Moody's said in a statement on Monday.

The ratings agency cited a return of Italy's economy to recession, government austerity measures that are hurting demand, rising problem loans and restricted access to market funding as among the factors behind its downgrades.

The downgrades are another setback for Italy's top five banks which have been asked to find about 15bn euros ($19.2bn) by June, part of tougher capital requirements set by the European Banking Authority due to vast holdings of domestic government bonds.

Unicredit and Intesa Sanpaolo, the country's biggest banks, were both given deposit ratings of A3 and a standalone bank financial strength rating of C-. Unicredit's credit assessment was baa2 while that of Intesa Sanpaolo was baa1.

Unione di Banche Italiane, Italy's fifth-largest bank, was given deposit ratings of Baa2 and a standalone bank financial strength rating of D+. The bank got baa3 rating for its baseline credit assessment.

The fourth-largest Banco Popolare got a Baa3 for deposits, D-plus for standalone bank financial strength and ba1 for its baseline credit assessment.

Credit quality hit by recession

Banco Popolare faced weak capital levels, insufficient internal capital generation and funding constraints, Moody's said.

The third-largest bank, Banca Monte Dei Paschi, got a Baa3 rating for deposits, D for standalone bank financial strength and ba2 for its baseline credit assessment.

"This bank faces more substantial challenges due to asset quality, capital and funding issues," the rating agency said.

Recession has worsened credit quality as Italian banks come under pressure from the government to put cheap funding from the European Central Bank to work in the real economy.

Moody's said in April that it would begin issuing conclusions to the various banking reviews currently under way for 114 European financial institutions, including Italian banks.

This process was to begin in mid-May and conclude by the end of June. This represented an extension of an earlier deadline for the rating reviews.

Italian banks scooped up 116bn euros ($148.7bn) from the Euopean Central Bank's long-term refinancing operation in December and another 139bn euros ($178bn) from the one in February.

Those funds helped them cope with frozen wholesale funding markets and a crippled interbank market at a time when the country has hovered close to the sharp end of the eurozone debt crisis.