UK’s Banking System Outlook Remains Negative, Says Moody’s

The outlook for the UK banking system remains negative, says Moody’s Investors Service in a new ‘Banking System Outlook’. The key drivers of the negative outlook are:

  • The UK’s uncertain economic prospects.
  • Downside risks for asset-quality.
  • Pressure on profitability due to net interest margin pressure, weak credit growth, and higher regulatory and compliance costs.

“The continued negative outlook for the UK banking sector is driven by the UK’s uncertain economic prospects, pressure on profitability and downside risks for asset-quality,” said Elisabeth Rudman, a Moody’s senior vice president (SVP). “These factors are partially offset by strengthened capital ratios, strong business franchises that are capable of generating strong underlying pre-provision earnings, and the banks’ progress in improving liquidity and reducing reliance on short-term funding.”

In addition, Moody’s continued view is that the probability of government support for systemically important institutions will decline over the medium term as authorities move towards implementing new recovery and resolution frameworks. This is reflected in a negative outlook on the senior debt and deposit ratings of the largest banks, which currently all incorporate very high assumptions of government support. However, Moody’s has a stable outlook on the standalone financial strength ratings of most banks and building societies, reflecting the fact that their standalone ratings incorporate to a certain extent the risks highlighted above.

Moody’s says that the weak economic growth prospects over the 12-18 month outlook period imply that the operating environment for UK banks will remain challenging. As previously noted in August, Moody’s expects UK economic growth to be marginally positive, although Moody’s central growth projection ranges from between -0.5% and 0.5% in 2012, with the macro-economic downside risks outweighing any positive factors.

Moody’s expects some further reductions in impairment charges over the next 12-18 months, as banks move past the worst of the asset quality problems that emerged over 2009-10, although the risks remain skewed to the downside due to the weak economic conditions. The asset quality of banks’ domestic mortgage lending portfolios are likely to remain supported over the outlook period by very low interest rates, relatively stable property prices and fairly steady unemployment levels.

Moody’s says that the areas of downside risk for banks are their exposures to the UK commercial real estate market and retail and corporate loan exposures in the European peripheral countries. Despite efforts to reduce exposures, some banks still have significant concentrations in commercial real estate and in Moody’s view, there is a risk of further defaults and higher provisions in this sector. In addition, although UK banks have limited exposure to sovereign debt from peripheral European countries, their other exposures (predominantly lower risk residential mortgages in Spain and Italy, and higher risk – but well provisioned – exposures in Ireland) could still be a source of further impairment charges. However, Moody’s scenario analysis suggests that UK banks have enough capital to absorb potential losses both under its central stress scenario and also under its adverse stress scenario.

Despite lower impairment charges, profitability is likely to remain under pressure over 2012-13 due to net interest margin pressures, the adverse growth environment, higher regulatory and compliance costs and subdued capital market activities. In particular, the larger banks have suffered from ongoing charges in relation to a variety of regulatory and compliance failures and given the tough regulatory environment we expect such costs to remain high. However, UK banks have implemented cost-cutting strategies that Moody’s believes will allow them to offset some of the challenges they face and broadly maintain their efficiency metrics over the outlook period


Related reading