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The Bank of England’s attempts to boost challenger banks by reforming capital rules could end up having a negative impact on their credit ratings, Moody’s has warned.

The BoE announced last week that it would change the way it sets rules on how smaller lenders calculate the riskiness of their loans. Under existing rules, newer banks typically need to hold relatively more capital than larger rivals, as they have less data to prove the robustness of their lending.

Their complaints have been taken up by politicians keen to break the hold of “too big to fail” banks on Britain’s high streets, and the BoE hoped its proposals would help to increase competition as well as discourage smaller banks from chasing riskier loans.

However, ratings agency Moody’s is not as convinced by the changes, describing them in its weekly update as “credit negative” for the British banking sector overall.

Analysts Aleksander Henskjold and Daniel Forssen said that increased competition will “negatively pressure margins and reduce profitability for all banks”, at a time when many groups are already struggling to boost revenues.

Moreover, they were also sceptical of the positive impact for smaller lenders in particular. The analysts argued that most of the affected companies that it rates were already managing to increase their lending faster than the wider market, while lower capital requirements will make creditors more susceptible to losses in the event of a failure.

From the report:

These banks’ low loan-to-value and residential mortgage focus means that they are likely to benefit from capital relief without significant incentives to change lending practices. However, all of these institutions have achieved material growth in their mortgage books over the past few years, targeting increases in volume to offset increasing margin pressure. We view negatively further incentives to foster growth for these firms through a relaxation of Pillar 2A capital requirements because doing so will weaken the affected banks’ stress capital resilience.

Copyright The Financial Times Limited 2017. All rights reserved.
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