Ratings agency warns fiscal tightening could threaten banks' recovery from the crash

Post-election belt-tightening could hinder rebuilding efforts by major banks in a "fragile" recovery, a leading ratings agency warned.

Fitch Ratings said recent better news on bad debts from major banks could prove "temporary" if moves to slash the deficit and higher interest rates sparked rising dole queues and a slide in house prices.

"A question mark remains over the extent to which low interest rates have merely delayed default by either corporate or household borrowers and the impact on default rates of the fiscal tightening that will inevitably follow the General Election," Fitch said.

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The agency also warned of risks faced by part-nationalised Royal Bank of Scotland and Lloyds Banking Group as state support for wholesale funding markets comes to an end.

The Bank of England special liquidity scheme and the Government's credit guarantee scheme finish in 2012 and 2013, posing a "key challenge" for both firms as they look elsewhere for funds.

Fitch's report added that any "material, sustained market disruption" in wholesale funding would be a "concern" to Lloyds and RBS, although the finances of Barclays and HSBC are on a much firmer footing.

Lloyds currently lends 1.69 for every 1 it takes in deposits – thanks to the heavy dependence of HBOS on wholesale markets – although RBS has improved its own loan-to-deposit ratio from 150 per cent to 134 per cent.

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According to Fitch, HSBC has the strongest funding position among UK banks with 83p lent for every 1 in deposits taken.

Fitch added that Barclays, HSBC and RBS were likely to see "solid" profits from investment banking this year although not at the bumper levels enjoyed by the major players in 2009.

A further risk – and potential dampener on profits – are the new regulatory burdens faced by major banks to prevent a repeat of the financial crisis.

New requirements on banks to hold more liquid – or easily sellable – assets in a crisis could impact lending, as well as a likely increase in the capital they need to hold.

"Regulation will be a key determinant of how the UK banking sector will evolve," it said.