Rating downgrade woes have plagued the U.K. banks. Rating agency Moody’s Investors Service, a wing of Moody’s Corp. (MCO), placed 14 U.K. banks and building societies on review for potential credit rating downgrades following the reluctance of the government to provide bailouts in future.
The rating reassessment does not reflect a financial weakness either in the banking system or in the part of the government. Rather, the assessment comes following the U.K. authorities initiatives to reduce capital injections from taxpayers’ money for banks that fail in the future.
Government support is an important factor and accounts for the perked up ratings for banks. In fact, a bank with a higher rating helps it to enjoy lower banks’ costs of funding. Therefore, with a downgrade, banks would face an increase in such costs and thereby an impact on profitability.
In case of a rating downgrade, U.K. banks such as Royal Bank of Scotland Group plc (RBS) and Lloyds Banking Group plc (LLOY.L) would face a tremendous setback as they have a significant state ownership. Their current ratings are thereby highly dependent on state support.
Besides these, the list for possible downgrades include the U.K. units of Banco Santander SA (STD), Bank of Ireland (IRE), Co-Operative Bank PLC, Coventry Building Society; Nationwide Building Society, Newcastle Building Society, Norwich & Peterborough Building Society, Nottingham Building Society, Principality Building Society, Skipton Building Society, West Bromwich Building Society and Yorkshire Building Society.
Huge government bailout during the financial crisis had saved the financial system in the U.K. and resisted any panic across the sector. However, U.K. banks have faced criticism that following the receipt of the bailout support, they have done little to strengthen the domestic economy by improving lending volumes to businesses. Yet, on the other hand, the executives enjoyed huge bonuses at the expense of taxpayers’ money.
In June 2010, the Chancellor of the Exchequer announced the creation of the Independent Commission on Banking (ICB), chaired by Sir John Vickers. The Commission has been asked to consider structural and related non-structural reforms to the U.K. banking sector to promote financial stability and competition, and to make recommendations to the government by the end of September 2011.
The proposed reforms by ICB include a significant cut in implicit subsidy for the banking system. Banks also need to protect their operations from risky investment activities and should strengthen their capital levels to avoid any future failure and thereby avoid the need for any capital infusion from taxpayers’ money. Yet, the complete abolishment of the government subsidy is highly unlikely.
In the absence of any proper mechanism to avoid any bank failure from creating financial instability, the rating agency also anticipates a high degree of government support for the major U.K. banks. However, given the current economic challenges and the regulatory uncertainties, we have a conservative outlook on the U.K. banking sector as a whole.
IRELAND BK-ADR (IRE): Free Stock Analysis Report
MOODYS CORP (MCO): Free Stock Analysis Report
ROYAL BK SC-ADR (RBS): Free Stock Analysis Report
BANCO SANTAN SA (STD): Free Stock Analysis Report
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