The UK's major banks are exposed to multi-milllion pound fines and lawsuits that could dent their profits, the rating's agency Moody's warned on Tuesday, as it downgraded its outlook for the sector because of new rules intended to prevent another taxpayer bailout.
The agency reduced its outlook from stable to negative, because of the uncertainty faced by lenders to banks as a result of the ringfencing high street arms from "casino" investment banking businesses. The new rules will mean taxpayers are less likely to bail out banks in the future.
The ringfences, born out of the independent commission on banking chaired by Sir John Vickers in 2011, need to be in place by 2019, but the HSBC chairman, Douglas Flint, has called on the government for time to make the changes, which the bank has argued will cost millions of pounds.
Flint said on Monday that there was a "growing fatigue" in some of the bank's operations, where staff were having to work at weekends to implement systems changes, in part caused by the ringfencing rules.
Moody's said: "We expect the related changes in business models, organisation and funding structure changes to have significant implementation costs over a multi-year period, which, given their early stage of development, have yet to be reflected in banks' bottom lines".
The agency, which advises lenders on the creditworthiness of banks, is basing its analysis on whether bondholders, for instance, would need to take losses when banks run into trouble - something that they did not do during the 2008 banking crisis, because the government stepped in to bail out banks.
Moody's is changing its outlook on the sector to reflect its view "that the improved operating environment and banks' stable financial fundamentals will not fully offset the negative credit implications of the finalisation of the UK resolution and bail-in regime and the related ring fencing framework".
"As a result of their final implementation, our current systemic support assumptions for UK banks will likely decline [during the next 12 to 18 months]," the agency said. It also has negative outlooks on the six largest UK financial institutions to reflect its expectations that taxpayers would be less likely to step in next time.
Its list of positive factors for the sector - stronger economic growth, improving profitability and fewer bad debts - is offset by the fact that UK banks are exposed to conduct and litigation charges which could hit profits and erode capital bases.
According to Moody's, the six largest banks have incurred £20bn of costs for payment protection insurance mis-selling, £4bn for interest rate swaps and £6.5bn for fines such as those for Libor rigging and money laundering offences.
"Banks will have to set aside additional provisions for PPI, but we believe these costs have peaked," Moody's said. "However the large UK banks still face potential material redress costs of the sale of interest-rate hedging products, upcoming settlements and fines from US and other cross-border investigations."
With the banks being subjected to stress tests to assess their ability to withstand shocks to the system, Moody's said it did not expect any of them to fail when the results are published later in the year.
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