For the first time since the 2008 financial crisis the ratings agency Moody's regards the outlook for the banking sector as being on a stable footing.
The agency has had a negative outlook on UK banks since May 2008 but on Wednesday upgraded it to stable as a result of the economic outlook and improving capital position of banks.
While the sector as a whole is on a stable outlook, the long-term debt and deposit ratings of the large banks remain on a negative outlook because Moody's believes that the UK authorities are trying to wean banks off taxpayer support in the event they face collapse in the future.
The announcement by Moody's came as the European Union set out rules that would put the onus on shareholders and bondholders to incur losses when banks are close to collapse rather than turn to taxpayers.
Although economic growth in the UK is expected to remain low, Moody's does not expect this to have an adverse effect on the operating environment for banks. The Bank of England has indicated that it expects interest rates to remain low which will help households and companies maintain their debt payments. "Moreover, unemployment has not increased as much as in previous recessions, supporting banks' asset quality," Moody's said.
While the banks are facing changes to regulation – requiring them to hold more capital and additional liquid assets that can be sold quickly – the agency said these should eventually mean that the systemic risk should be reduced.
Moody's has conducted its own stress tests and concluded that the five major banks – Lloyds Banking Group, Royal Bank of Scotland, HSBC, Barclays and Santander in the UK – would be able to absorb losses under very stressed conditions. The closely watched measure of capital strength – known as the tier one ratio – would be 10.3% under a base scenario and fall to 6.9% under the more severe stressed scenario.
The Prudential Regulation Authority, which regulates the major lenders, last month published the results of its own stress tests and has ordered RBS, Lloyds, Barclays, Nationwide Building Society and the Co-operative Bank to find extra capital.
One of the main risks to a bank is commercial property lending and exposure to peripheral European economics.
"We believe that UK banks are sufficiently well-capitalised to sustain expected losses from both our central and adverse stress scenarios. More specifically, once the large UK banks execute their capital plans (which we deem achievable) to address the additional capital buffer requirements recently imposed by the PRA, we believe that UK banks will be well capitalised for the risks they face and will compare favourably to their European peers," Moody's said.
The report by Moody's comes as the UK prepares to sell off its 39% stake in Lloyds with its 81% stake in RBS expected to be disposed of later.
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