October 11, 2019 /02:52 PM / By Fitch Ratings / Header
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The UK's major banks face the challenges of Brexit from a position of strength, Fitch Ratings says in its latest peer review report on the sector. The uncertainties in relation to the UK's exit from the EU remain material but the banks are well-capitalised, impaired loans are at a cyclical low and liquidity buffers are sound. Net profitability is still under pressure but the end of PPI-related customer redress will soon remove a major drag on net income, and cost-cutting continues. Nevertheless, a no-deal Brexit could cause substantial disruption to UK economic prospects and result in negative rating actions on banks, most likely with Negative Outlooks assigned.
The Long-Term Issuer Default Ratings of UK banks are on Rating Watch Negative (RWN) to reflect uncertainty over the nature and timing of the UK's exit from the EU and the associated downside risk to ratings. If a Brexit agreement is concluded, all else being equal, Fitch would likely resolve the RWNs and assign Stable Outlooks.
The implications of a no-deal Brexit on UK growth are highly uncertain, but a Fitch scenario indicates that leaving without a deal could result in GDP falling by more than 3% over two years relative to Fitch's baseline. A no-deal exit on 31 October 2019 could see a sharp real GDP contraction in 4Q19, reducing real GDP growth to 0.7% for 2019. Real GDP would contract by about 1.5% in 2020, which would be a deeper recession than that of 1991, and unemployment would rise to around 5.5%. This compares to Fitch's forecast of real GDP growth of 1.2% in 2020 if a transitional deal is reached.
Under such a no-deal scenario, it is highly likely that UK banks' asset quality would deteriorate. However, improved underwriting standards since the last financial crisis should reduce the likelihood of a sharp deterioration, and we would expect policy rate cuts and potentially additional quantitative easing, which would help borrowers to service their loans. These measures would also be beneficial for banks' funding costs.