Britain's leading banks are strongly capitalized and have taken a cautious approach to provisions, but they may yet be tripped up by a slower-than-expected economic recovery, according to analysts.

They can also expect significant credit losses in the domestic U.K. market, with S&P Global Ratings predicting the figure for 2021 will be double what it was in 2019, albeit lower than in 2020.

Robust capital

NatWest Group PLC reported a common equity Tier 1 ratio of 18.5% at the end of 2020, although this dipped slightly to 18.2% by the end of the first quarter of 2021. This is still not far short of double its statutory minimum requirement of 9.0%, however.

In common with the most other major U.K. banks, NatWest CEO Alison Rose has promised to start paying dividends as soon as possible.

Lloyds Banking Group PLC is the other major bank of the top five in the U.K. that has seen the largest increase in its CET1 ratio, up from an excess requirement of 1.4% at the end of 2019 to 5.9% at the end of the first quarter of 2021.

Both NatWest and Lloyds are primarily U.K.-based banks, with relatively little exposure to overseas markets, and both are heavily dependent on the British economy. Both banks, too, saw a steady increase in deposits over the period as consumers reduced spending on travel, entertainment and holiday costs.

Indeed, Lloyds saw total customer deposits increase by £39 billion in 2020, with retail deposits up £31 billion, while small and medium-sized enterprise deposits were up £13 billion, partially driven by government-backed lending held on deposit.

HSBC Holdings PLC and Standard Chartered PLC, in contrast, have far greater exposure to overseas markets, with HSBC making most of its profits in Hong Kong and mainland China while Standard Chartered has significant operations in Asia and Africa.

Barclays PLC, which saw its liquidity coverage ratio rise sharply during the height of the pandemic, is the only one of the main British banks to have a significant investment banking operation in major markets. At the height of the first wave of the pandemic last year, second-quarter income at the investment banking operations increased by 19% to £3.32 billion. In the first quarter of 2021, 60% of group income came from banking, markets and corporate clients, said CEO Jes Staley, helping to offset the headwinds affecting the bank's consumer business.

Pauline Lambert, executive director in the financial institutions team at Scope Ratings, said the possibility of a weaker economic rebound in the wake of the pandemic is something the banks would be focused on.

"The question is 'how much of a recovery is there going to be?' Is this going to be a weaker recovery, is it going to take much longer before we return to pre-pandemic levels, will Brexit finally show its head and cause more of a drag on the economy?" said Lambert, speaking to S&P Global Market Intelligence.

U.K. Treasury forecasts show the country is expected to see GDP growth of 5.7% this year and 5.6% in 2022.

Lambert warned, too, of the potential losses that the banks would incur when the government's jobs support scheme ends later in 2021 and as businesses that have borrowed from state-backed loans face repayment.

"The losses that are to come as the support programs roll away will start to become realized in the later part of this year. The feeling is that the banks have taken sufficient provisioning to accommodate for that, as long as they don't release those provisions too quickly," she said.

Impairment releases

NatWest, Lloyds and HSBC each announced an impairment release when unveiling first-quarter results, while Barclays took a sharply reduced impairment charge of £55 million, down 97% from £2.1 billion in the first quarter of last year.

But NatWest CEO Alison Rose said that while the bank saw the potential for a more rapid recovery, it remained cautious.

Will Edwards, S&P Global Ratings analyst, said banks are still wary of releasing loan loss provisions while the course of the pandemic remains uncertain. He cited Santander, where CEO José Antonio Álvarez has said the bank had "barely used" last year's provisions but there remained "significant uncertainties" in SME and corporate loan books, so the bank would not release provisions this quarter.

"A lot of banks' provisions remain on their books through an abundance of caution. Unlike American peers, they have yet to release them," said Edwards.

Though the vaccine rollout in the U.K. has been an undoubted success, COVID-19 infections are now rising sharply again as the delta variant, first detected in India, spreads. As a result, the government is coming under pressure from some scientists to delay the full reopening of the economy due June 21, when virtually all restrictions are set to be lifted.

"I think this highlights that there are tail risks with the pandemic. The risk is that, come that September period when the fiscal support disappears, it could potentially be a cliff-edge type of transition away from it and then you could see the risk that the banks' models have pointed towards crystallize even if, within the year, they have released provisions," said Edwards.

He still expected domestic credit losses across U.K. banks to be around £8 billion for the year. This is a fall of almost 40% from 2020, but still around double 2019 levels for the sector.

"The key risk is that we get this choppy exit when provisions are released but have to be rebuilt and we get this very uneven income development for the rest of the year," Edwards said.