UK banks shrug off tariffs and fiscal concerns with higher margins

TwentyFour
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Over the last week or so, the major UK banks have been reporting results for the first six months of 2025. Considering the noise around the UK’s fiscal situation and some softening in broader macroeconomic conditions, these releases offer another valuable data point for analysing the health of the UK economy and the operating environment of UK banks.

In addition to allowing investors like us to update individual banks’ credit profiles, bank results can provide valuable insight into the capacity of the sector to lend to the economy, and offer a first-hand perspective on how lenders expect credit conditions to evolve from here. For us, the two key takeaways are that the reported robust returns provide some buffer against any future economic weakness, and loan provisioning levels are not pointing to any imminent deterioration in asset quality.

First, with respect to the reported performance of the major UK banks, it is worth noting that the sector is coming off a strong comparable period in 2024. The average Bank of England (BoE) interest rate in the first half of 2024 was 5.25%, which led to a significant improvement in deposit margins and net interest margin (NIM). The average BoE rate dropped to around 4.5% in the first half of 2025, which could have been a headwind for the sector, but for the banks that have reported so far, we have seen NIM expand to 2.5% from 2.3% in the same period in H1 2024.

In this respect, we note the strong contribution of the so-called “structural hedge” in bank margins. UK banks use financial instruments such as interest rate swaps, bonds and other derivatives to stabilise the interest rate risk on their balance sheets. The idea is that banks are not in the business of placing directional bets on whether interest rates will move up or down; they are in the business of underwriting borrowers and lending money, at a spread over their cost of funding that reflects the underlying risk of that borrower not paying them back. Specifically, banks hedge a portion of their liabilities (normally current accounts and equity) by matching these against assets in the form of a portfolio of securities with a duration of roughly 4-5 years. In the first six months of 2025, we have seen the lower yielding bonds used in this hedge (purchased when rates were much lower) maturing, with the proceeds being reinvested in higher yielding instruments. As and when interest rates continue to trend lower, the benefit of this “structural hedge” will begin to tail off, but at present this is still helping to boost margins.

Second, in terms of UK banks’ operating environment, the H1 2025 figures we have seen so far show cost of risk (CoR) has been resilient. CoR reflects the annualised value of loan loss provisions against the total stock of loans on a bank’s balance sheet – this metric rose to 0.16% in H1 2025 across the banks that have reported so far, higher than the 0.04% figure for H1 2024, though in that period banks were still benefiting from releasing provisions they had taken in anticipation of weaker operating conditions that did not materialise. The current level of provisioning is still very much below the average for a business cycle. It is also worth noting that while the UK faces a number of fiscal concerns, these have so far not had a major impact on the demand or supply of credit.

Provisioning data can be additionally helpful to investors, as banks are required to book provisions against expected losses based on their current view of credit risk, thanks to a rule change some years ago that made provisions forward-looking rather than backward-looking. At the onset of Covid-19, for example, banks hiked their provisions significantly based on the expected deterioration they were seeing on the horizon rather than actual realised losses. If this latest reporting season is anything to go by, the behaviour of their customers is not prompting UK banks to expect an imminent deterioration in credit quality. 

The H1 2025 reporting season has been a useful data point for investors to assess the impact of fiscal worries and the wider tariff turmoil on operating conditions for the UK banking sector. Encouragingly, it doesn’t look like the banks are set to experience stress any time soon, and even in a scenario of macro data deteriorating faster than anticipated, the sector would enter a period of more challenging conditions from a relatively strong position.
 

 

 

 

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