The downgrades come at a difficult time for the region's banks and could raise their borrowing costs, although analysts believe Swedish banks will continue to perform better relative to European peers due to their high capitalization.

Moody's, which warned in February it could cut the ratings of 17 global and 114 European financial firms to reflect more fragile funding conditions, wider credit spreads, and a tougher operating environment, downgraded Nordea's (NDA.ST) and Handelsbanken's (SHBa.ST) debt ratings one notch to leave their deposit ratings at Aa3, from Aa2 previously.

Norwegian group DNB (DNB.OL) was downgraded one notch to A1/C- due to its reliance on market funding and exposure to volatile businesses, such as commercial real estate and shipping.

DNB said it disagreed with the downgrade, saying it had good access to funding and its shipping portfolio was stable.

"We do not agree with their reasons, mainly those concerning our funding markets; we believe we have good access to all markets, Europe, USA, Japan and Australia for that matter," spokesman Thomas Midteide said.

CAPITAL BUFFERS

Nordic banks have some of the highest capital levels in Europe and have had uninterrupted access to funding markets, backed by healthy economic growth and strong fiscal positions in both Sweden and Norway.

But the spillover from the euro zone debt crisis has triggered a wave of downgrades for banks and sovereigns, and Moody's has already cut ratings for Italian and Spanish banks.

Moody's downgraded Nordea's and Handelsbanken's debt ratings one notch to leave their deposit ratings at Aa3, still at the high end of western European banks.

It had flagged investors for a one notch cut on Nordea and a two notch downgrade for Handelsbanken. DNB's downgrade was also better than an expected two-notch downgrade.

"The outcome was clearly better than expected," Exane BNP Paribas Andreas Hakansson said in a note. "This leaves Swedish banks at a very strong comparable level, with Nordea and SHB probably being some of the very few double AA rated banks. This supports our view that Sweden is attractive."

Swedish banking shares were up slightly in Friday morning trade, in line with the broader Stockholm bourse. DNB shares were also higher.

The ratings for Swedbank (SWEDa.ST) and SEB (SEBa.ST), both of which hold lower ratings than their two larger Swedish peers, were unchanged. Both had been flagged for one notch downgrades.

Swedish banks hold some of the highest capital levels in Europe and Moody's noted that they were in a stronger position overall to handle the credit risks spawned by the crisis.

Swedish Financial Markets Minister Peter Norman said the report showed Sweden had a stable bank sector.

"If one looks at the Swedish banks compared with the European banks Sweden is almost in a class of its own," he told Sweden's TT news service.

Still, Moody's noted risks also for the Nordic banks, pointing to their high reliance on wholesale funding, modest profitability due to price competition for retail loans and the export-orientated economy's exposure to problems in Europe.

The asset risks also stemmed from the banks' large, mostly variable-rate mortgage books would be vulnerable to a credit deterioration if interest rates rise.

A spokesman at the region's biggest bank, Nordea, said the decision would likely have only a marginal impact on funding costs, adding it remained one of the strongest banks in Europe.

Handelsbanken said investors were comfortable with the bank's position.

"No bank in the Nordic region has a higher rating than Handelsbanken. No funding is cheaper in Europe than Handelsbanken's," said Handelsbanken spokesman Bengt Carlsson.

SEB also said it has one of the strongest balance sheets and is active in the most stable markets in Europe, saying its clients were well-prepared for the uncertain economic climate.

(Additional reporting by Niklas Pollard and Sven Nordenstam in Stockholm and Ole Petter Skonnord in Oslo; Editing by Alistair Scrutton and Louise Heavens)

• A Permanent Economic Emergency