Banks’ strength called into question as falling provisions boost profit

Changes in pre-tax profits for 2004 varied from a rise of 35% for HSBC to a fall of 20% for Lloyds TSB. Abbey returned to profitability in the year it was taken over by Banco Santander of Spain.

But, as is often the case with banks, the headline figures can be misleading. For example, profits can increase because of rising revenues or a reduction in bad debt provisions compared with the previous year. Over the longer term, revenue growth is more likely to provide sustainable profits growth.

Jamie Hooper, a fund manager in the UK alpha team at F&C, says that this time around provisions have generally played the key role: “Most of the banks seem to have met expectations because of positive movements in provisions.”

Once such factors are taken into account, the relative performance of the banks looks rather different. HSBC’s profits were at the lower end of market expectations as it benefited from disposals and from a sharp reduction in provisions. In contrast, Lloyds TSB, the only one of the large banks with lower profits than in 2003, was seen as more encouraging. Lloyds disposed of non-core assets in 2003, so its revenue last year was lower as a result.

Andrew Green, a director of UK equities at SG Asset Management, says that it is important to differentiate between the domestic and foreign sides of the banks’ operations. “Domestic banks were very much in line with expectations,” he says.

Lending growth within domestic banking was robust and bad debts were under control. His main concern was the sharp rise in costs at Barclays.

Analysts are also closely watching the impact of macroeconomic developments in Britain on the banking sector over the coming year. Higher interest rates and rising inflation would probably hit the banks’ profitability. However, stronger corporate borrowing could be beneficial.

A housing market crash would be a particularly pernicious development for the British banking sector, but there is substantial debate about how likely it is to happen.