UK banks defied the downgrade by rating agency Moody's, with Lloyds Banking Group moving higher despite the news.
Moody's cut the ratings of 15 banks on Thursday, including Royal Bank of Scotland, Barclays, HSBC and Lloyds. Barclays saw its credit rating cut by two grades from Aa3 to A2. HSBC, RBS and Lloyds suffered a reduction of one to Aa3, Baa1 and A2 respectively.
Analysts said the pending downgrades had already been reflected in the banks' share prices since Moody's said on 15 February that it was reviewing 17 banks with capital-markets operations because of fragile confidence and tighter regulations that pinched revenue.
It seemed that the Treasury had also predicted the move, prompting it to launch two new stimulus packages on 15 June to "inject confidence". Together with the government, the Treasury's support plans will provide billions of pounds of cheap credit to banks to lend to companies. Banks will also have access to short-term money to deal with "exceptional market stresses".
However, already grappling with weak profits and global economic turmoil, there is a risk that the Moody's downgrade could do more damage to the banks' bottom lines and further unsettle equity markets. Analysts also warned these increased costs could be passed on to families and businesses.
Royal Bank of Scotland issued a statement in response to the downgrade, saying: "The group disagrees with Moody's ratings change which the group feels is backward-looking and does not give adequate credit for the substantial improvements the group has made to its balance sheet, funding and risk profile."
It reminded investors that both Standard & Poor's and Fitch Ratings have rated the bank 'A' with a stable outlook, and have upgraded the stand-alone rating by more than one notch over the past 18 months.
Nonetheless, it reassured markets that the impact of the downgrade was "manageable", given its £153 billion liquidity portfolio. The amount of collateral that may have to be posted following this one notch downgrade by Moody's is estimated to be £9 billion as of 31 May.
"The group continues to maintain a solid liquidity and funding position," said RBS, adding that it had completed its planned wholesale funding requirements for 2012.
Lloyds put a positive spin on the downgrade, stating: "In their rating, Moody's have recognised the strength of our leading UK-based customer franchises and substantial progress we have made in delivering our strategic plan.
"Moody's have particularly acknowledged our strong capital ratios and our track record of delivering on our restructuring targets, including the integration of HBOS, the reduction of non-core assets, and our progress on strengthening the bank's funding and liquidity profile."
The bank acknowledged that the lowering of the senior debt and deposit ratings reflected the challenging operating environment in the UK and also in Europe and its use of wholesale funding, but stressed the new ratings were not expected to have a material effect on its funding costs and market capacity.
This article was written for our sister website Interactive Investor