S and P: Latest UK credit loss estimates
Benign economic conditions and low debt servicing costs have helped UK banks to maintain a low level of domestic credit losses in recent years. We estimate that such losses will be around £9bn, or just 0.32% of domestic loans, this year. 2019 losses would need to rise to around £18bn – double our estimate–to reach their long-run average.
We forecast that losses over the next two years will tick up somewhat – to 0.43% in 2020 and 0.56% in 2021- still below their long-term average. Our forecasts reflect our expectation that unemployment will remain low, interest rates will increase only gradually from their current very low levels, and economic growth will remain muted but above a 1% annual growth rate on average. That said, we see risks skewed to the downside, given potential negative economic implications from factors such as Brexit, global trade tensions, and political volatility affecting the confidence of UK households and the willingness of businesses to invest. We also note that the UK household sector remains highly leveraged compared to some peer countries and these forecasts are therefore more vulnerable to an economic downturn. For further insights on our credit loss estimates, see attached report.
We have also published today our updated overall assessment of the UK banking sector, in a report titled “Banking Industry Country Risk Assessment: United Kingdom.” As set out in that report, we continue to classify the banking sector of the UK (AA/Negative/A-1+) in group ‘3’ under our Banking Industry Country Risk Assessment (BICRA). We rank BICRAs on a scale of 1 to 10, where group ‘1’ represents the lowest-risk banking systems. Other countries in group ‘3’ are Australia, Chile, Czech Republic, Denmark, France, Israel, Japan, Korea, Netherlands, and the US.
We use our BICRA economic risk and industry risk scores to determine a bank’s anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in the U.K. remains at ‘bbb+’.
In our BICRA on the U.K., we consider the following strengths:
A wealthy and diversified economy that benefits from monetary and exchange rate flexibility.
- Minimal net external funding of the banking system and deep U.K. debt capital markets.
- High industry stability; even with a dynamic fintech sector, a limited number of established players will continue to dominate the banking sector and underlying profitability remains attractive.
- The banking sector is predominately focused on more stable domestic and commercial banking operations; investment banking makes a lower contribution than in the past.
We also consider the following weaknesses:
- Leaving the EU (Brexit) represents a risk to U.K. economic prospects and could create a tougher operating environment for banks as the UK adjusts to a new trading relationship with the EU, its largest trading partner.
- Private-sector leverage remains higher than many peers.
The key factor that supports our assessment of the UK banking sector’s economic risk of ‘4’ is the UK’s economic resilience, which is underpinned by its wealth and macroeconomic policy flexibility. The assessment is constrained by the high level of private sector leverage, and leaving the EU could create a more challenging operating environment, particularly in the event of a disruptive Brexit where no transitional arrangements have been agreed.
We base our UK banking sector industry risk assessment of ‘3’ in consideration of the sector’s institutional framework, consisting of a supervisory regime that was strengthened following the financial crisis; competitive dynamics, which show high market concentration and moderate risk appetites; and the sector’s has minimal net external funding needs.
This report does not constitute a rating action.