A close up of a magnifying glass rests on top of a bar graph that shows declining sales or performance over a quarterly basis. The image is photographed using a very shallow depth of field.

Mortgage-focused Lloyds Banking Group PLC (LON:LLOY) and OneSavings Bank PLC (LON:OSB) have been provided a boost by the Bank of England’s emergency rate cut earlier Wednesday.

However, the UK’s High Street lenders were put on notice by the Prudential Regulation Authority, which told them not to waste cash on boosting dividends and bonuses.

Not too many investors will shed a tear over bankers being forced to wear hair shirts.

However, there will be a shudder from long-suffering holders of the formerly state-owned Lloyds and Royal Bank of Scotland (LON:RBS), which will no doubt be revisiting their dividend policies following the PRA edict.

Indeed, across the industry there will likely be a focus on re-allocating cash to ensure the capital cushion is plump enough to stave off the recessionary impacts of coronavirus and the sharp slump in oil prices.

This brings us neatly to a piece of research carried out by Russ Mould, the investment director of the fund platform AJ Bell (LON:AJB), pointing to the recent travails of the UK banks.

He notes that across the board net interest margins – the difference between what is paid out in interest compared with what banks receive – have been on the decline for the last five years.

To reverse the trend our big names of financial services require:

  • Positive interest rates
  • A steep yield curve (where long-term interest rates are higher than near-term ones)
  • Wide credit spreads (where loans to companies generate a fat premium rate relative to benchmark government loan rates)

“All three are missing at the moment,” Mould said.

This, he said, explains why return on tangible equity targets are being missed; banking stocks trade at or on a discount to net asset value; and the shares are performing terribly.

“Nor is this a new trend,” Mould said.

“The FTSE All-Share Banks index has been anchored by even-ever flattening yield curve for some time, as central banks have cut headline interest rates and tried to lower costs for borrowers. This is good for borrowers, bad for banks.”