UK banks remain attractive investment opportunities despite recent challenges, according to UBS.
A mixed picture for lenders was highlighted by the investment bank, with benefits for the sector from a stable base of customer deposits but facing pressure due to policy changes and potential future tax increases.
UBS recommends Barclays PLC (LSE:BARC) as its top pick, maintaining a 'buy' advice, while NatWest Group PLC (LSE:NWG) carries the same rating. Lloyds Banking Group PLC (LSE:LLOY) shares are seen as fairly valued, resulting in a 'neutral' call from UBS.
The Swiss bank's analysis points to the stabilisation of deposit rates and growth in sight deposits (accounts that allow instant access to funds).
This is a positive development, as these lower-yielding deposits provide banks with a steady income stream.
However, UBS warns that with interest rates likely to fall, banks will face pressure to pass these reductions on to customers, potentially limiting their profits in the near term.
The investment bank also notes that while UK banks have performed well over the last year, recent months have seen weaker growth, as concerns about third-quarter earnings and possible increases in bank taxation weigh on investors' minds.
Despite these risks, UBS believes UK domestic banks offer good value compared to their European counterparts, trading at lower price-to-earnings ratios while still delivering solid returns on equity.
Looking ahead, UBS expects further improvements in banks' net interest income (the difference between interest earned on loans and paid on deposits) even as central bank rates decline. The key factor will be how quickly banks adjust their deposit pricing.
The upcoming UK government budget, expected at the end of October, could introduce new taxes on the banking sector, adding uncertainty to the outlook.
In morning trading, shares in Barclays, NatWest and Lloyds were flat.