UK banks face negative credit outlook, economic downturn poses challenges

UK banks face negative credit outlook, economic downturn poses challenges


The fundamental credit outlook for the UK banking system is negative, as the domestic economy has entered a downturn that is likely to result in an increase in bad debts for lenders as well as lower lending volumes and lower profitability, Moody's Investors Service said in its new Banking System Outlook for Britain.



Moody's negative outlook for the UK banking system expresses the rating agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades.



The rating agency's central risk scenario for the UK economy assumes a marked slowdown in private consumption in 2008, driven by more restrictive borrowing conditions, and a downward correction in house prices -- all of which poses challenges for the UK banking system.



"In addition, the global credit crisis continues to lead to significant writedowns of structured exposures for some of the larger UK banks and funding stresses for smaller institutions. Relatively lower capital levels at some of the UK banks have left them less well prepared to enter a more challenging operating environment," said the authors of the report.



Moody's continues to examine the ability of banks to absorb the stresses through their capital and earnings.



Despite the challenges, Moody's still considers the overall financial strength of the UK banking sector to be strong. The large banks have solid franchises supported by considerable diversification of earnings by product and geography, and strong liquidity underpinned by diversified funding sources and stable deposit bases.



"The liquidity crisis at Northern Rock -- and the subsequent time it took regulators and governments to finalise their response to such a crisis -- has led to a sharp re-focus on the liquidity planning of UK institutions and stability of their funding sources. Notwithstanding this incident, our analysis suggests that the liquidity position of the major UK banks remains stable and well diversified," Moody's analysts explain.



The rating agency's key concerns for mortgage lenders are asset quality and funding. However, on the basis of its stress tests, Moody's does not expect the underlying asset quality of the mortgage lenders' portfolios to deteriorate to such an extent that it eats into their core capital base. In addition, whilst some mortgage lenders have very strong retail deposit bases, those that do not have put in place additional funding measures that should enable them to weather the difficulties in the capital markets.



Moody's has taken rating actions on nine entities within the UK banking sector since the start of the credit crisis, primarily as a result of these challenges. Although it believes most entities can manage the downturn at current rating levels, some further adjustments of ratings are possible in 2008.

FINANCIAL MIRROR