Moody's downgrades UK banking system to 'negative' due to Brexit uncertainty

Moody’s Investors Service changed the outlook on the UK’s banking system to 'negative' from 'stable' on Wednesday, due to uncertain Brexit trade talks.

Moody’s, one of the big three credit rating agencies, said the change reflected the increased uncertainty surrounding Brexit trade talks with the European Union which would lead to weaker credit fundamentals for the country’s banks in the next 12-18 months.

Carlos Suarez Duarte, a senior vice-president at Moody's said: "Increased uncertainty about the UK's future trade relationship with the EU will likely lead to reduced confidence and lower investment and consumer spending in the UK.

"This will, in turn, pressure revenues, asset quality and profitability metrics for all banks in the UK, though some are more resilient to these pressures than others."

On 8 July, Moody's said UK banks' operating environment would weaken and forecast real gross domestic product growth in the country to slow to 1.5% in 2016 and 1.2% in 2017.

Its previous base case expectations were 1.8% in 2016 and 2.1% in 2017.

Moody's said it expected UK banks to see their asset quality worsen, with problem loans rising from a low 2.7% of gross loans as of the end of 2015.

But deterioration starting in 2017 will be gradual, with low levels of unemployment and low interest rates which would alleviate risk.

Duarte added: "We expect some lag between the deceleration of the overall UK economy and any deterioration in the individual position of households and non-financial corporates”.

UK banks' profitability are to come under pressure, according to Moody’s, driven by weaker credit demand on the back of heightened uncertainty, a higher cost of risk as asset quality weakens, and pressure on net interest margins with interest rates remaining low for longer.

Some UK banks might have to suffer additional costs in restructuring their business models in order to service European clients as they depend on access to the single market.

However, Moody’s said that British banks have strong funding and liquidity profiles, and are expected to stay solid over the next 12-18 months.

Moody’s also said it anticipated the Bank of England to support the banking system through the provision of contingent liquidity support.