Outlook for UK banking sector in the wake of credit crunch

In its latest Market View report, Alliance Trust says UK banks still have relatively low capital ratios, compared to their European, North American and Asian peers, leading to ongoing uncertainty over the strength of their balance sheets. On this basis, further capital raising cannot be ruled out.

While the slowing UK economy, driven by a weaker housing market, has been a key factor in banks' recent poor performance, not all banks have been affected to the same extent. Domestically oriented banks are much more exposed to any movements of the UK economy. Global players, such as HSBC, have been able to avoid the full impact of the credit crunch so far through their exposure to the Asian markets. However, this shelter may not last as Asian economies are reliant on the U.S. as an export market. Therefore, a prolonged slowdown of the US economy, coupled with rising inflation in Asian countries, may begin to affect UK banks with Asian interests.

In this environment, exposure to commercial property will remain another area of concern for UK banks as some have been aggressive in increasing their property exposure over the last few years. However, their focus has been on well let investment property rather than more risky developments and this is shielding these banks to some extent from the current volatility of the commercial property market.

The outlook for UK banks remains challenging and largely dependent on the stabilisation of the US and UK economies, particularly these countries' housing markets. Consolidation may be on the cards for some of the smaller mortgage focused banks, but potential buyers are likely to hold off until economic conditions have stabilised.

Tim Gibbens, Global Financials Analyst at Alliance Trust comments: "The credit crunch has hit the UK banking sector very hard and, after some difficult months, valuations are starting to look better but we are not out of the woods yet. Despite banks raising more than £20 billion of capital over the last year, we cannot rule out further moves to shore up balance sheets."

"Not all banks have been affected by the global credit crunch in the same way. Among the UK banks, those with less exposure to the US and UK housing markets and greater exposure to Asia have fared relatively well. The key areas to monitor now are the strength of banks' capital and liquidity positions as well as their exposure to commercial property and specialist mortgage markets where prices may weaken further."

"When conditions eventually stabilise, banking stocks are likely to experience a sharp bounce but it may be short-lived. Tough fundamentals such as a relative lack of growth options, pressure on margins from increased competition and still-stretched capital positions will soon reassert themselves."