By Sudip Kar-Gupta
LONDON (Reuters) - Credit rating agency Moody's downgraded Britain's part-nationalized banks Lloyds and Royal Bank of Scotland on Friday, although Britain's finance minister said UK banks were well-placed to cope with a European debt crisis.
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The cuts to RBS and Lloyds formed part of a broader downgrade of 12 British financial companies by Moody's, which had already been flagged by the agency earlier in the year.
Moody's cut RBS by two notches to A2 from Aa3, and downgraded Lloyds TSB by one notch to A1 from Aa3. It also cut its ratings on Santander UK, the Co-Operative Bank, Nationwide Building Society and seven other smaller British building societies.
Moody's did not change its rating on Barclays and HSBC, which along with RBS and Lloyds represent the "Big Four" group of lenders that dominate British banking.
"Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions, which continue to incorporate up to three notches of uplift," it said in a statement.
"However, it is more likely now to allow smaller institutions to fail if they become financially troubled. The downgrades do not reflect a deterioration in the financial strength of the banking system or that of the government," it added.
RBS shares were down 1.8 percent in early morning trade, while Lloyds fell by 2.6 percent. The shares of both banks have consistently traded well below the level at which the British taxpayer originally acquired their RBS and Lloyds stakes following the 2008 bailouts of the companies.
"The downgrades have been well flagged, reflecting removal of government support through guaranteed liquidity schemes and low probability of future tax-payer bail-outs," Oriel Securities said in a research note.
OSBORNE SEEKS TO REASSURE
Europe's sovereign debt crisis, sparked by Greece's economic woes, has led to concerns that many banks will need further injections of capital.
Earlier this week, France and Belgium intervened to prop up European bank Dexia, whose financial strength had been eroded by the sovereign debt turmoil.
However, British finance minister George Osborne said Britain's banks remained well-capitalized and in better shape than many of their European rivals, who face bigger losses on writedowns to their holdings of Greek government debt.
In an interview with BBC radio, Osborne also said that the Bank of England's decision to pump more money into the economy and the government's deficit reduction plans would help shield Britain from the euro zone debt crisis.
Osborne said: "People ask me 'how are you going to avoid Britain and the British taxpayer bailing out banks in the future?'
"This government is taking steps to do that, and therefore credit rating agencies and others will say 'well, actually these banks have got to show that they can pay their way in the world'.
"And I am confident that British banks are well capitalized, they are liquid, they aren't experiencing the kind of problems that some of the banks in the euro zone are experiencing at the moment."
Lloyds said the Moody's downgrade would only have a "minimal" impact on its funding costs, while RBS reiterated that it remained strongly capitalized and had strengthened its credit profile.
Britain ended up with an 83 percent stake in RBS and a 40 percent holding in rival Lloyds after rescuing both banks during the 2008 credit crisis with taxpayer bailouts.
However, the British taxpayer is currently sitting on losses of billions of pounds on their RBS and Lloyds stakes.
RBS was trading at 23.76 pence, more than 50 percent below the average 49.9 pence price at which the taxpayer acquired its stake in the lender, while Lloyds was at 35.58 pence -- again a fraction of the 63 pence price at which Britain got its stake in the bank.
(Additional reporting by Avril Ormsby and Tim Castle; Editing by Erica Billingham and Mike Nesbit)