OREANDA-NEWS. The outcome of the EU referendum will create a challenging macro-environment with negative implications for UK banks' domestic operations, says Fitch Ratings. The uncertainty following the referendum will result in an abrupt slowdown in near-term GDP growth, although we expect the impact to be manageable at the banks' rating levels. But ratings could be downgraded if the economic effect of Brexit is either protracted or particularly severe.

The Stable Outlooks on most rated UK banks reflect our view that they have built solid capital buffers and have strong liquidity and stable funding, which render them resilient to moderate shocks. We expect pressure on bank profitability from "lower for longer" base rates that further squeeze margins, a slowdown in business volume growth, and higher loan impairment charges (LICs). Our ratings already factored in deteriorating asset quality caused by a cyclical slowdown, but this is likely to be exacerbated. Pressure on operating costs will continue to weigh on profitability, but we think conduct fines have peaked at most banks, providing some headroom to offset revenue weakness and higher LICs.

UK banks have been operating in a supportive environment for at least three years. Falling unemployment and prolonged low base rates have resulted in low volumes of new impaired loans. Banks have also taken advantage of the benign economic conditions and rising investor appetite to dispose of legacy non-core assets, and boosted the reserve coverage of older impaired loans. These have gradually weighed less heavily on balance sheets, so tail risk has reduced ahead of the anticipated economic slowdown.

UK banks are exposed to the residential and commercial property markets, which makes their performance vulnerable to falling asset values. Low base rates help affordability, but a material rise in unemployment, reduced investor appetite, and inflationary pressure on consumer prices would have a negative impact on banks' loan books and result in higher LICs.

The UK banks' capitalisation should enable them to withstand moderate deterioration in the operating environment at their current rating level. More stringent regulatory requirements, partly based on a series of stress tests undertaken by the Bank of England, have been aimed at ensuring that UK banks are able to withstand severe shocks. Strong liquidity, including access to liquidity from the Bank of England, should enable banks to withstand periods of market dislocation where wholesale funding is not available or is expensive.

Fitch has published a special report on Brexit and the UK banks, which is available at www. fitchratings. com or by clicking the link above.